By Tiernan Ray

Jefferies & Co.’s Atul Goyal today starts coverage of Nintendo (7974JP) with a Buy rating and a price target of ¥21,000 on the ordinary shares and a $26.80 price target on the American Depository Receipts (NTDOY), writing that investors should be excited about the prospect the company will miss — miss — expectations for a ¥100 billion operating profit as its “3DS” and “Wii-U” mobile devices miss the mark.

Goyal thinks Nintendo will be forced to reform its approach to gaming and will start selling its software titles on mobile devices such as smartphones and tablets, rather than pushing its hardware as its sole avenue of distribution.

Nintendo “has set itself up for a very big earnings miss (this year) and a rather bigger miss this entire cycle,” writes Goyal.

He thinks the company may deliver a ¥20 billion profit this fiscal year ending in March, well below the ¥100 billion company forecast and the ¥76 billion Street consensus, on revenue of perhaps ¥673 billion, below Street consensus of ¥883 billion and the company’s projection for ¥920 billion.

And for 2015, he sees a loss of ¥5 billion versus a consensus of ¥108 billion.

About 65% of Nintendo sales come from hardware such as the 3DS and Wii, writes Goyal, the rest from software, the majority of it being handheld software, making up 23% of total company revenue.

Revenue has been going higher while profits have been going lower, writes Goyal, suggesting the company is badly positioned in the latest round of console and handheld gaming machines, especially with Microsoft (MSFT) and Sony (SNE) set to roll out new home gaming consoles:

While revenues are the highest (ex the FY3/07 till FY3/11 from DS + Wii), yet its gross margins are the lowest in last 30 years. In the recently released results, Nintendo’s gross profits were ¥140b. For the first time since FY3/91, have Nintendo’s gross profits fallen below ¥150b. That does show, how poorly its products are selling and how poorly it has positioned itself in this particular cycle.

Nintendo’s Wii U has been hurt by being priced at $350 for a market for casual gamers that are price sensitive, writes Goyal. He sees bad signs already for the machine:

It is very clear, that Wii had strong momentum from the beginning – both in hardware and software sales. Gamers and observers expressed their affection for Wii console from the very start when it was first shown (at E3) and its novel game-play with Wii-mote. Meanwhile, Wii U sales have been extremely weak. These may be disappointing for the company, but in our view, these are not disappointing for the market. Since the launch of Wii U, gamers / observers have been expressing extreme caution / pessimism about Wii U. We do note that Nintendo sold (sell-in) c. 3.45m units in the first quarter of its launch but then managed only c. 0.39m units (sell-in) in the Jan-Mar quarter, presumably as the retailers were still stuck with plenty of inventory. For the Jan-Mar quarter, Wii U sales in US added up to c. 190, 000 units (i.e. global sell-in was c. 2x of the US sales (sell-through)) […] Using the same yardsticks, if Apr-May trend continues in June as well, that will imply a total of c.100,000 units of Wii U sales (sell through) in US, which could mean global sales (sell-in) of 200,000 – 250,000 units of Wii U in Apr-Jun quarter. Such weak sales trends will make it a struggle to sell even 2mn units this year, even with the help of a big 3Q.

The existing 3DS machine, meanwhile, is in a “state of decline”:

3DS has already started to decline. This is even before Nintendo has started to divert game developer resources towards Wii U. As Nintendo tries to ignite sales for Wii U, it will take away more resources from 3DS, which will further diminish the appeal of 3DS. Already, 3DS hardware and software has started to fade when compared to DS sales.

Against that sorry state of affairs, Goyal thinks Apple‘s (AAPL) App Store and Google‘s (GOOG) Google Play stores for its mobile platforms are driving sales in the mobile gaming market:

3DS has already started to decline. This is even before Nintendo has started to divert game developer resources towards Wii U. As Nintendo tries to ignite sales for Wii U, it will take away more resources from 3DS, which will further diminish the appeal of 3DS. Already, 3DS hardware and software has started to fade when compared to DS sales.

Nintendo has missed management projections the last four years, which is not strictly a consequence of a weaker yen, writes Goyal. He thinks that although management has strongly refused in past to sell Nintendo’s games on other companies’ hardware, nevertheless, CEO Satoru Iwata has made a “commitment” to shareholders to deliver profit. That is a very strong promise in Japanese corporate culture, writes Goyal, and if the company misses in a big way, as he predicts, Iwata may have to deliver a new strategy:

In our view, it is highly unlikely that Nintendo will come even close to its FY3/13 forecast of ¥100b in OP. We believe that this could trigger a meaningful change. In our view, after having been seen as completely opposed to offer its games on mobile-platforms, it is not easy for the management to change its view. However, with its comments about ‚commitment‛ and about ‚responsibility‛, in our view, the management has elegantly set the stage for a change / turnaround. In a low- probability event (we assume 20%) that they can meet this year’s OP of ¥100b, the stock will likely rise and the management will get a bit longer rope. But in all probability (we assign 80%) Nintendo will miss its ‚commitment‛ by a wide margin. That will give the management an elegant way out to change direction / strategy. It will be able to say that it has tried its level best. And that it has no other choice left but to offer games on other platforms. That said, we don’t think that this acknowledgement will come before the year-end.

Nintendo shares today fell ¥130, or 1%, to ¥11,840 in Tokyo trading. The ADRs are down 8 cents, or half a percent, at $14.76.

Add a Comment

We welcome thoughtful comments from readers. Please comply with our guidelines. Our blogs do not require the use of your real name.

Comment

There are 11 comments

JULY 8, 2013 2:53 P.M.

Anonymous wrote:

This guy couldn't be more wrong. Nintendo is not known for doing the thing that investors and gamers want them to do. Nintendo just recently posted its first annual loss in more than three decades! They're not in a position where they'll be forced to completely abandon a business model that has worked for them for a very long time. They could probably put forth two or three more underperforming hardware offerings before they consider a change. Nintendo has always just done its own thing, and they're not likely to be caught up in this stupid mobile gaming buzz.

JULY 8, 2013 2:56 P.M.

This is no fun. wrote:

Why can't we talk about Peter Misek, Jeffries and Blackberry? That's where it's really at. He said the future is about Blackberry and MDM. Ha!

JULY 8, 2013 4:41 P.M.

Seth A Drekin wrote:

"Such weak sales trends will make it a struggle to sell even 2mn units this year, even with the help of a big 3Q"

I've seen a lot of ignorant predictions about Nintendo's performance for this fiscal year, but this may well be the most out of touch of them all. Nintendo is practically guaranteed to sell more than 2 Million Wii U's in Q3 alone. They are likely to sell closer to 4 million. The so called Competition, whom Nintendo doesn't even intend to compete with, are guaranteed to be under stocked. They are the ones you need to be concerned about breaking 2 million units. They never have before.

With an extremely well planned Fall software Lineup, Sony and Microsoft's inevitable launch problems, and a massive amount of children begging for Christmas presents, Nintendo doesn't need to worry about selling Units through this year. They need to worry about selling Units next year.

JULY 9, 2013 1:30 A.M.

AnonDev wrote:

It is really amazing how off base analysts can be. It would be a blessing for Nintendo if they could go private again. Mario Kart Wii alone generated over 1 billion dollars in software sales for Nintendo.That is one game. Pokémon This fall will generate hundreds of millions if not a billion dollars when all is said and done.

Why would Nintendo want to chase after the 99 cent market when they do quite well in the real world. They would need to sell untold hundreds of millions of copies on the iOS and Google store to even approach what they make on their big titles with a smaller userbase. Going after the iOS market would drop the value of their products and in return cause them to lose even more money long term. That is the problem with analysts etc. They don't care about the long term health of a company they are in it for the now give it to me now mentality.

JULY 9, 2013 12:16 P.M.

shuddup wrote:

lmao how is 3ds declining, when just recently it became the best selling game hardware this month on npd. Say what you want but the 3ds hardware sales are getting better and better. If anything is declining its the playstation vita. how come no one hardly say anything about sonys mis step with that hardware? the 3ds is miles and above of the vita in every are, from software sales to hardware sales.

JULY 9, 2013 12:22 P.M.

Whatsallthisthen wrote:

3DS has already started to decline? Yeah 250,000 units last week and over 32 Million sold since launch is a real sign of impending doom.

It would be interesting if the idiots writing this crap actually did some research before they print garbage.

JULY 9, 2013 12:24 P.M.

Jason Thompson wrote:

People have been predicting the demise of Nintendo's hardware business since 1991. Anyone who predicts this simply does not understand Nintendo's fan culture or the product that Nintendo puts out. Predicting that Nintendo will leave the gaming hardware business would be like predicting that Disney would leave the animation business. Nintendo produces the only high quality real alternative to the type of games found on other consoles. Nintendo has an IP portfolio that other companies dream about. Nintendo has cash in the bank and consistently profit.

JULY 9, 2013 2:05 P.M.

Steve wrote:

What a load of crap. 3ds is on fire and come August wii u will make a come back. Never count nintendo out. Only idiots do that.

JULY 9, 2013 4:33 P.M.

Shadao wrote:

There is no logic behind this. At. All. How could the 3DS be in decline when it's one of the highest selling systems as of now? Animal Crossing, Fire Emblem, and Luigi's Mansion are big-selling software, not to mention arrival of juggernaut Pokemon X and Y is coming this October.

JULY 13, 2013 11:00 P.M.

Confused Gamer wrote:

The Wii U is a mobile device? Silly me for playing it plugged into the wall.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.